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Being familiar with the most common basic accounting terms can help avoid misunderstandings with those who keep the books for your business. Industries tend to have their own language, and accounting is no different. Being familiar with the most basic accounting terms, abbreviations, and acronyms can prevent confusion. To help you start building an accounting vocabulary, here is an assortment of basic financial and accounting terms.

What are the Most Important Balance Sheet Terms?

A balance sheet provides a snapshot of the financial condition of a business at a specific time. It is most often used at the close of an accounting period. Balance sheets list the assets, liabilities, and equity belonging to the owner or the stockholders. It contains both assets and liabilities, including short and long-term obligations. At any point in time, the assets should equal the company’s liabilities added to the owner’s equity.

1. Liability (L) 

A liability is a debt a company has not yet paid. Current and noncurrent liabilities may be on a balance sheet. Liabilities are important because they often represent some assets of a company. For example, a loan for equipment is a liability, but the equipment is an asset. Other examples of common liabilities businesses have include payroll, loans, and accounts payable. 

2. Accounts Receivable (AR)

Accounts Receivable (AR) include all the company’s revenue that has not yet been collected. On the balance sheet, AR is recorded as an asset that will be converted to cash in the near future. For example, Accounts Receivable are usually from services or products supplied on credit, or at least without payment upfront. They are essential because they are included in a company’s assets. 

3. Inventory

Inventory counts as an asset in accounting. The company usually has items on hand that they intend to liquidate through sales. Inventory encompasses assets ready for sale, products in the process of being made, and the materials needed to make them. Examples of items in a company’s inventory include products ready for sale, packing and packaging materials, and raw materials.

4. Accounts payable (AP)

Accounts payable are expenses incurred by a business that has not been paid yet. These are recorded as a liability on a Balance Sheet since it is a debt the company owes. Examples include invoices, unpaid bills, bank loans, and lines of credit debts.

5. Book Value (BV)

As assets depreciate, they lose value. The Book Value records the asset’s original value minus any depreciation. An example of Book Value would be if a company purchased a machine for $50,000 and its value depreciates at $10,000 per year. After the second year, its Book Value would be $30,000.

6. Equity (E)

Equity is a term used to describe how much money would be left after a business sold off its assets and paid off all of its debts. In essence, it defines how much stake investors and owners hold in a company. Examples of types of equity include common stock, contributed surplus, and paid-in capital.

7. Asset (A)

Assets are resources, or items of value owned or controlled by a business. An asset can be from a past business activity. Or the business expects them to generate economic value in the future. They may be current or noncurrent, intangible, physical, operating, and nonoperating. Some asset classes include cash, equities, real estate, fixed income, intellectual property, and others.

8. Balance Sheet (BS)

Balance sheets are official financial statements for a company. It contains specifics that explain the current financial state of the business, including liabilities, assets, and the owner’s equity. Accountants use a variety of formats to create balance sheets such as classified, vertical, comparative, or common-size balance sheets. Each format presents information that together provides a snapshot of the company’s financial position.

9. Accrued Expense

Accrued expenses are expenses that have been incurred but are not yet been paid. An entry is made to document the money owed before there is an exchange of money which will resolve the transaction. In essence, the company recognizes a cost before it is paid.

What are the Most Important Income Statement Terms?

Income statements are essential financial statements for a company. It shows the profits and losses over a specified period of time. The income statement is one of the three main statements used in accounting and corporate finance. It logically organizes and displays the revenue, costs, gross profit, administrative costs, selling expenses, and other expenses and income, net profit, and taxes. 

1. Cost of Goods Sold (COGS)

COGS or the cost of goods sold refers to direct expenses required to produce goods sold by a business. The formula varies depending on the product being produced. One example would be the cost of purchasing raw materials and parts and the employee labor required to produce the product.

2. Revenue (Sales) (Rev)

Revenue is the income earned by a business by selling products or services as part of its primary operations. For example, the revenue for a restaurant includes the sales of food and beverages.  It doesn’t include income from other sources such as liquidating equipment.

3. Expense (Cost)

Expenses are the costs associated with what a business needs to operate. There are a variety of day-to-day expenses for businesses, including fixed expenses, variable expenses, accrued expenses, and operating expenses.

4. Net Income (NI)

The net income (NI) for a business is the dollar amount they earn in profits. To calculate the net income, all the business expenses are subtracted from its revenue during a period. This includes COGS, depreciation, taxes, and overhead.

5. Depreciation (Dep)

Depreciation only applies to fixed assets. These are long-term resources an organization uses to generate income or build wealth. Some common examples include real estate, machinery, and equipment. Fixed assets lose value over time and an accountant will record the decline as depreciation.

6. Income Statement (P&L) (IS or P&L)

An income statement specifies the total revenue the company earns over an accounting period. Expenses incurred in the same period are subtracted to provide a financial statement. An income statement is one of the three basic financial statements businesses issue. The other two include a cash flow statement and a balance sheet.

7. Gross Profit (GP)

Gross profit is the value of products or services sold by a business before the cost of the goods sold is accounted for. If the gross profit ends up being a negative number, it’s considered a gross loss. The gross profit is in contrast to the net profit which is the actual amount earned once the costs are accounted for. 

8. Net Margin

The net margin reflects a percentage that represents the profit a company has as it is related to its revenue. To calculate the net margin, divide the net income by the revenue for a specific accounting period.

9. Gross Margin (GM)

A company’s gross margin is the money they retain after they’ve incurred its direct costs. It is calculated by subtracting the cost of goods sold (COGS) from the net sales. 

What are the General Terms in Accounting?

There are numerous general terms used by accounting professionals. Having knowledge of these terms can help alleviate confusion and bring understanding to the tasks accountants perform to help you and your business. Take a look at these general accounting terms.

1. General Ledger (GL)

The GL or general ledger contains the complete record of all the financial transactions of the company. It is used to prepare all the financial statements. Examples of individual accounts found in the general ledger include equity, liability, and asset accounts. Every transaction that is recorded in the general ledger or one of the sub-accounts is called a journal entry.

2. Liquidity

The term, liquidity, refers to how easy an asset can be sold for cash. Any assets that are easy to convert to cash are called liquid assets. Some common examples of liquid assets include securities, money market instruments, and accounts receivable.

3. Return on Investment (ROI)

ROI or the return on investment is used when evaluating the financial performance as it relates to monies invested. To calculate the ROI, divide the net profit by the investment cost. The result is usually expressed as a percentage. For example, a company spent $1000 on a marketing campaign which led to a profit of $2000. Their ROI on the spend would be calculated as 50%.

4. Cash Flow (CF)

The cash flow describes the inflow and outflow of cash through a business. To determine the net cash flow for an accounting period, or any period of time, the end cash balance is subtracted from the beginning cash balance. If the result is a positive number, then more cash flowed into the business than what flowed out. A negative number would mean more money flowed out of the business than what was brought in.

5. Payroll

A company’s payroll contains the payments made to employees including salaries, wages, deductions, and bonuses. On a balance sheet, this often appears as a liability if an employee has accrued vacation pay or unpaid wages that the company owes.

6. Generally Accepted Accounting Principles (GAAP)

The GAAP is a collection of rules that all accountants abide by. The general rules were first established to make it easier to make comparisons between financial reports of businesses. Abiding by these industry-developed rules is critical for companies so that there are no misunderstandings or misleading information being shared.

7. Trial Balance (TB)

The trial balance is a document used by businesses to report their general ledger account at a specific point in time. An accountant generates a trial balance at the end of a reporting period to make sure that all the accounts and balances are calculated properly. It provides a professional test run of the official balance sheet.

8. Business (or Legal) Entity

A business entity is the type of business or its legal structure. Some examples of various business formations include Limited Liability Corp (LLC), Sole Proprietor, S-Corp, C-Corp, and a partnership. Each legal entity has its own requirements, tax implications, and laws.

9. Allocation

Allocation is the process of dividing up costs between various activities or departments in a company. The process includes identifying, accumulating, and assigning the costs to various branches of the company. For example, your business pays $3000 in property insurance each year for two buildings it owns. If one building is 2000 square feet and the other is 4000 square feet, the insurance cost can be allocated to each building based on their sizes.

10. Credit

A credit is an accounting entry that may either increase liabilities or decrease assets. Functionally, they are opposite debits. Credits are placed on the right side of accounting documents. 

11. Overhead

Overhead refers to costs or expenses that are necessary to sustain normal business operations. They do not necessarily contribute to the products or services provided by the company. Some examples of overhead costs include insurance, rent or mortgage payments, advertising costs, and administrative costs.

12. Present Value (PV)

Present value is an accounting term used to refer to the value of an asset today. Sometimes, accountants make projections for the future regarding revenue, debts, and expenses. PV or present value describes future funds as present-day calculated adjustments. Present value is useful for understanding that having $100 today is worth more than receiving the same amount in the future since money now can be invested for a higher rate of return.

13. Fixed Cost (FC)

Fixed costs do not change with sales volumes. For example, costs such as salaries and rent do not change if sales increase. 

14. Receipts

Receipts are official written records made for a financial transaction or a purchase. A receipt serves as proof that a transaction occurred. This is an important document as it allows transactions to be processed for tax purposes.

15. Interest

Interest is charged on a loan or line of credit. It is calculated as a percentage of the amount borrowed. Interest is paid in addition to the principal balance.

16. Certified Public Accountant (CPA)

A CPA or certified public accountant is an accounting professional who has obtained a special license. Their license certifies them to provide consulting, taxation, auditing, and accounting services. A CPA may work for a business or an individual. Candidates have to meet eligibility criteria as well as pass a four-part exam to obtain a CPA license. 

17. Enrolled Agent (EA)

An accounting professional who passes tests to demonstrate expertise in personal and business taxes can have the designation of an enrolled agent. In most cases, an enrolled agent is needed to complete business tax filings. An EA represents the taxpayers and ensures compliance with the IRS.

18. Accounting Period

All financial statements including balance sheets, cash flow statements, and income statements designate an accounting period. An accounting period is a span of time reported in each of the statements. It may be monthly, quarterly, or another time span.

19. Journal Entry (JE)

A JE or journal entry expresses updates and changes made to a company’s books. Each journal entry consists of a unique identifier, the date, an amount, debit/credit, and an account code. The account code expresses which account has been altered.

20. Diversification

Diversification helps reduce risks. Capital is allocated across numerous assets so that a single asset’s performance doesn’t dictate the performance in its entirety. 

21. Debt

Debt is a financial obligation incurred by a company during business operations. In accounting, a debt entry increases liabilities and decreases assets. Functionally, they are opposite credits. In accounting documents, debts are placed on the left side column. A debt is anything owed to another party. Common examples include a mortgage, equipment loan, or other business loans.

22. Variable Cost (VC)

A variable cost is a business expense that changes. One example is the cost of producing more products. In contrast, a fixed cost does not change such as rent. Another example of variable costs includes tax rates that change as a result of sales and profits.

23. On Credit/On Account

Partial payments on liabilities and debts, called “on credit” are tracked by accountants. The terms on credit or on account payments describe services or products sold without receiving the payment upfront. For example, if a business purchases $3000 worth of merchandise on credit or with a deferred payment it increases their accounts payable by $3000 if they did not render payment at the time the goods were received.

24. Material

The term material in accounting refers to whether information has an influence on business decisions. For example, when a company has millions of dollars in revenue, a dollar is not material. The Generally Accepted Accounting Principles require the disclosure of any material considerations.

What is the Importance of Knowing Accounting Terms?

As a business owner, it is essential to be familiar with the most common accounting terms. Your financial records reflect the operations of your business. Knowing terms associated with the finances of your business helps you understand the importance of your accountant’s role. It’s also essential for understanding the performance of your business. Knowing what kinds of reports you need and their role in your business, equips you to make good business decisions.

Anyone who deals with the finances of a business needs to know the basic accounting terms. Firstly,  this helps you understand the benefit and value an accountant brings to your company. Secondly, you will not be confused when your accountant presents their reports or financial findings. You will be able to understand their findings and their reasonings. 

What are the Concepts to Know in Accounting?

Most industries have a vernacular specific to their primary tasks and responsibilities. Accounting professionals are no different. A quick Google search will reveal literally hundreds of accounting terms that business professionals need to learn. While they are important to accountants, business owners and supervisory staff only need a general knowledge of the key concepts of accounting. 

In accounting, there are certain concepts that accountants use as basic guidelines. Following these concepts or standards ensures a level playing field and prevents discrepancies and misunderstandings. The essential accounting concepts include:

  • Availability – All accounting information is to be available to clients in a timely fashion.
  • Completeness – Accounting information should always be complete in every respect.
  • Consistency – Policies and procedures should be applied consistently over time so financial statements are comparable and consistent.
  • Conservative – Estimates of revenue should not be overstated and estimates of expenses should not be understated.
  • Entity Basis – Financial statements should represent only the business and be kept separate from the owners.
  • Going Concern – Accounting records and reports should be completed with the idea that the business will continue to operate continuously into the foreseeable future.
  • Matching – Revenue and expenses 
  • Materiality – Accountants should record any financial information that could materially affect business decisions.